When shopping for mutual funds, a healthy dose of skepticism can be a good thing.
This is especially true when viewing some of the ads that appear in newspapers, magazines or on television.
Most are designed to simply catch the eye; they are not meant to fully inform.
Problems often arise when people use those ads to make investment decisions, never reading the prospectus or other important financial documents.
“Anyone who makes a decision based solely on an ad probably isn’t making an informed decision,” said Lori Lucas, an editor at Morningstar, a Chicago firm that analyzes mutual funds.
Though most of the ads are factual, she said, the information often is presented in a misleading fashion.
To illustrate that point, Morningstar recently published an article titled “Lies, Damn Lies and Fund Advertisements.” It focused on a series of ads by The Pilgrim Group, a mutual-fund company in Los Angeles.
One ad began: “Has anything like this ever happened before?”
It then included the following list in bold type:
1. Pilgrim Adjustable Rate Securities Trust III
2. Pilgrim Adjustable Rate Securities Trust II
3. Pilgrim Adjustable Rate Securities Trust I
4. Pilgrim GNMA Fund
5. Pilgrim Regional Bankshares
Finally, the ads gave a toll-free number where investors could learn more about that “unprecedented performance.”
The real picture?
At first blush, a person seeing those ads might think the Pilgrim Group had swept the top five spots in the overall 1992 performance rankings.
It had not. Hundreds of funds had performed better in 1992. However, to get the full picture, a person seeing those ads would have to read the fine print along the bottom of the page.
The Pilgrim funds were, indeed, ranked one through five, but only when grouped into a small subset of mutual-fund categories. For example, some of the Pilgrim funds competed in a group of about 50 other funds. Their rankings would have been considerably lower had they been lumped into a broader category.
“The facts were given,” Lucas said, “but they were given in a way that is very misleading.”
The Pilgrim Group says its ads were not misleading, and they have demanded a retraction from Morningstar.
The Pilgrim Group is by no means the only mutual-fund company with ads that might possibly mislead investors.
Part of the problem may be the rating system itself. If a mutual-fund company tries hard enough, almost any fund can give itself a top rating in some category.
Meanwhile, investors are stuck with the task of weeding through that jungle of confusion. And things may get a lot worse in the future.
New rule proposed
Federal regulators are now considering a proposal that would allow investors to buy mutual funds directly from printed ads, by sending in a coupon. Currently, all would-be investors must be given a mutual-fund prospectus before they can buy.
The proposal to allow “off-the-page” sales has widespread support among mutual-fund companies. The issue will likely be decided later this year by the Securities and Exchange Commission.
Industry officials say it would actually help investors. For one thing, it would require all mutual-fund ads to include certain information, such as fees and long-term performance. Funds also would be required to use the same formula when calculating yield.
“The ads will end up being something like a mini-prospectus,” said John Collins, a spokesman at the Investment Company Institute, a mutual-fund trade group in Washington.
Even so, picking a mutual fund on the basis of an ad is risky business. Most people don’t choose a car because they happen to like the commercial. They look at performance and affordability, too. Mutual funds are no different.
To get a true picture of a specific fund, it may be necessary to compare that fund with similar funds. Or, at the very least, an investor should request an annual report along with the prospectus.
“If an ad is a sole source of information, I think you have opened the door to misleading investors and causing them to believe things that are not true,” Lucas said.
